‘Market tantrums’ can arise without leverage, according to study

The country’s biggest banks and funds don’t have nearly the same leverage as they did before the financial crisis — but that may not be enough to escape “market tantrums,” according to a study released at a conference attended by several Federal Reserve officials.

A study authored by J.P. Morgan chief U.S. economist Michael Feroli, University of Chicago Booth School of Business professor Anil Kashya, New York University professor Kermit Schoenholtz and Princeton University professor Hyun Song Shin argues that wide fluctuation in risk premiums can occur without a buildup of leverage. The study was presented at the Chicago Booth global markets conference held Friday.

“Using inflows and outflows for different types of open-end mutual funds, we find some support for the proposition that market tantrums can arise without any leverage or actions taken by leveraged intermediaries,” the authors say. “We also uncover connections between the destabilizing flows and shocks to monetary policy.”

The study has some important implications for Federal Reserve policy — notably, that an absence of leverage isn’t enough to ensure financial stability. The study also suggests more instability to come when, like the summer of 2013, investors infer monetary policy will tighten.

The study doesn’t try to bless or criticize the Fed’s purchases of bonds and forward guidance communication. But it “does suggest that unconventional monetary policies (including QE and forward guidance) can build future hazards by encouraging certain types of risk-taking that are not easily reversed in a controlled manner,” the authors say.